Saturday, September 20, 2014

Nigeria holds rate but worried over inflation, FX rate

Nigeria's central bank maintained its policy rate at 12.0 percent but said it was concerned about the potential impact on inflation and the exchange rate from banks' high level of liquidity that was not being used for productive and profitable lending to the real sector of the economy.
The Central Bank of Nigeria (CBN), which has kept its rate steady since October 2011, encouraged banks to lend excess reserves to the real economy but noted their "apathy to lending" and their inclination to place an additional 866 billion naira in the banking system from maturing bonds in October into the Standing Deposit Facility or use it to increase pressure on the exchange rate.
The central bank's Monetary Policy Committee was split between further tightening the monetary policy stance but a majority voted to retain the Monetary Policy Rate (MPR) at 12 percent with a corridor of plus/minus 200 basis points, the public sector Cash Reserve Requirement (CRR) at 75.0 percent and the private sector CRR at 15.0 percent.
CBN issued the following statement:

"The Monetary Policy Committee (MPC) met on September 18 and
19, 2014 with all the 12 members in attendance. The Chairman
welcomed the new member, representing the Board of the Central
Bank of Nigeria, Mr. Stanley I. Lawson to membership of the
Committee. The meeting held against the backdrop of the
increasingly limited choices for monetary policy, particularly, in the
emerging market and developing economies; tapered recovery in
the euro area coupled with the social and political tensions in the
domestic and global environment, some of which have had
fundamental impact on domestic macroeconomic management.
The Committee reviewed key developments in the global and
domestic economy up to mid-September 2014, and the outlook for
the near-term.

International Economic Developments
The Committee noted the slow global growth prospects as the IMF,
in July, marked down its projection by 0.3 per cent to 3.4 per cent,
reflecting weak economic recovery, particularly in the Euro Area,
and a less than optimistic outlook for several emerging market
economies. Global growth which moderated more than expected
in the first quarter of 2014 regained momentum in the second
quarter although recovery remained largely uneven. The United
States provided strong tailwinds for growth recovery but fiscal
constraints continued to limit robust possibilities. Similarly, economic
activity in the United Kingdom maintained a strong momentum in
the second quarter, supported by improved household confidence
and an impressively recovering housing market. Growth in China also
recovered following the fiscal policy stimulus and a surge in credit.
In contrast, growth moderated in Japan after the VAT hike in April,
but the quantitative easing programme of the Bank of Japan
continues to support recovery. Growth in the Euro area is expected
to strengthen to 1.1 per cent in 2014 and 1.5 per cent in 2015, but
would remain uneven across the region, reflecting continued
financial fragmentation, impaired private and public sector balance
sheets, and high unemployment in some EU economies. In the
emerging markets and developing economies, growth is projected

at 4.6 per cent in 2014, which is 0.2 percentage point lower than the earlier projection. The sources of growth include strong external
demand from the advanced economies; however, tight financial
condition is expected to dampen growth in domestic aggregate
demand.Global inflation has remained relatively stable while spare capacity
remains large, suggesting no significant inflationary pressures in the
short-to-medium-term. The stance of monetary policy has remained
unchanged across most advanced and emerging economies in
view of the unclear outlook for monetary conditions and financial
stability especially in the post-QE tapering era. The expectations of
increase in policy interest rate remain in focus in the US and the UK,
even though the Fed reaffirmed that it would maintain the current
highly accommodative monetary policy stance. The European
Central Bank (ECB) and Peoples Bank of China (PBoC) have also
announced new monetary stimulus programmes which will
moderate the impact of the end of QE3 on frontier markets.

Domestic Economic and Financial Development
Output
The Committee noted the continued resilience of the economy as
real GDP grew by 6.54 per cent in Q2, 2014 compared with 5.40 per
cent in the corresponding quarter of 2013. The observed growth rate
also surpassed the 6.21 per cent recorded in the Q1 of 2014. The
non-oil sector remained the main driver of growth recording 6.71 per
cent in Q2, 2014; although lower than the 8.21 and 8.88 per cent
recorded in Q1, 2014 and the corresponding quarter of 2013,
respectively. The decline in growth of non-oil GDP was traced to the
decline in agricultural output, construction, trade and services
relative to the levels recorded in Q1, 2014. The slowdown in
agricultural output was attributed to the insurgency activities in the
North Eastern axis and some parts of the North Central States which
led to displacement of farming communities, thereby limiting
agricultural activities and, hence, output from that region.

Growth in the services and industry sectors remained relatively stable
compared with the corresponding period in 2013. The Committee
commended all levels of government and the general population
for the coordinated, prompt and effective response to the Ebola
Virus Disease (EVD) in Lagos and Port Harcourt; two cities that are
commercial hubs and leading growth axes for the service and
industry sectors of the economy.

The oil sector grew by 5.14 per cent in Q2 2014, a marked reversal
from the decline recorded in the preceding four quarters. The
Committee welcomed the intensification of efforts by government at
addressing vandalism of oil facilities and theft of crude oil in the
Niger Delta region as well as efforts towards addressing gas supply
shortages to the power plants. The Committee reiterated its
commitment to continue to support the efforts, in addition to
facilitating other measures aimed at promoting inclusive non-
inflationary growth.
Prices
Headline inflation rose to 8.5 per cent in August from 8.3 in July 2014.
The mild but sustained underlying inflationary pressures were
attributable mainly to food production and distribution challenges
posed by the insurgency activities. From 9.4 per cent in April 2014,
food inflation, measured on a year-on-year basis, rose to 10.0 per
cent in August while core inflation moderated consecutively in the
last two months since June 2014. In August 2014, the year-on-year
core inflation was 6.3 per cent, down from 8.1 and 7.1 per cent in
June and July, respectively. The Committee was concerned that the
insurgency was forcing a switching from domestic to imported food
to meet domestic shortfall with huge impact on external reserves
and underscored the need to expedite action to restore normalcy to

the troubled region to sustain the tempo of growth. The Committee further reaffirmed its commitment to sustain efforts at ensuring price
stability.

Monetary, Credit and Financial Markets’
Developments
Broad money supply (M2) grew by 2.94 per cent in August 2014 over
the level at end-December 2013 compared with 4.83 per cent in
July. The annualized growth of 4.41 per cent in August 2014 was
below the growth benchmark of 14.52 per cent for the year. Net
domestic credit, however, increased by 5.31 per cent in August
relative to the end-December 2013 level. When annualized, net
domestic credit rose by 7.96 per cent, compared with the growth
benchmark of 28.5 per cent for fiscal 2014. The rather slow expansion
in money supply in August reflected the 10.17 per cent contraction in
net foreign assets of the banking system (NFA).

Money market interest rates, however, remained within the MPR
corridor as the overnight and collaterized OBB rates moderated from
11.30 and 11.49 per cent in August to 11. 08 and 10.62 per cent on 11
September 2014, respectively. The MPC noted that both rates traded
around the lower band of the MPR corridor on account of the
liquidity surfeit in the banking system.

Activities in the capital market were bearish during the period with
the All-Share Index (ASI) decreasing by 4.3 per cent from 42,482.48
on June 30, 2014 to 40,672.94 on September 12, 2014. Market
Capitalization (MC) also decreased by 4.3 per cent from N14.03
trillion on June 30, 2014 to N13.43 trillion on September 12, 2014.
Market indicators declined owing to the profit taking activities of
investors.
External Sector Developments

The average naira exchange rate remained considerably stable in
all segments of the foreign exchange market. The exchange rate at
the retail-Dutch Auction System Segment (rDAS) was stable at
N157.29/US$, but depreciated at the inter-bank and substantially at
the BDC segments between July and August 29, 2014. At the
interbank segment, the naira depreciated slightly by N0.32 or 0.20
per cent to $/N162.40 from $/N162.08. Similarly, at the BDC segment,
the exchange rate depreciated by N2.00 or 1.2 per cent from
US$/N167.00 to U$/N169.00. The premium between the rDAS and
interbank rates was 3.25 per cent while that between the rDAS and
BDC rates stood at 7.45 per cent in the review period. Gross official
reserves rose from US$39.1 billion at end-July to US$40.7 billion on 17th
September, 2014. The current level of external reserves provides
approximately 7 months of imports cover.

The Committee’s Considerations
The MPC expressed satisfaction with the relative stability in the
economy while also noting the risks that lie ahead. The key risks
include: the possibility of capital reversals as the Fed’s Quantitative
Easing in the US finally ends in October, amidst dwindling oil output
and declining oil prices, domestic security challenges and upward
trending headline inflation. The Committee further expressed
concern about high banking system liquidity and its potential effects
on inflation and the exchange rate. The policy challenges, the
Committee noted, would include sustaining the stability of the naira
exchange rate, managing the vulnerability to capital flow reversal,
building fiscal buffers to insure against global shocks, managing
inflation and exchange rate expectations and safeguarding the
financial system stability as well as a buildup in election related
spending.
The Committee welcomed the efforts by government to address
some of the constraints and risks to economic activity like the
insurgency in the North-East and the Ebola Virus Disease epidemic. It
noted that as progress is made in these areas and in respect of other
constraints like power and improving SME financing, the outlook for
growth appears bright and prospects for upward price pressure
would be moderated. The Committee further noted that the

restrictive stance of monetary policy provided important defenses against structural liquidity in the banking system and also reaffirmed
the willingness to play a key role in managing expectations around
exchange rate and inflation vulnerabilities. Consequently, adequate
consideration would need to be accorded the goal of reining-in
banking system liquidity to safeguard the objective of price stability.

The Committee was, however, concerned that banks were holding
large excess reserves averaging over N300 billion even when there
were ample opportunities for productive and profitable lending to
the real sector of the economy. The concern was further
strengthened by the reality of injecting an additional N866 billion into
the system through the redemption of maturing AMCON bonds in
October. Given the apathy to lending, banks may be inclined more
to placing these new funds in the SDF or use it to increase pressure
on the exchange rate. The Committee advised the Bank to explore
ways of encouraging banks to lend such excess reserves to the real
sector.

In light of the foregoing and consideration of other key risk factors,
the Committee was of the view that the direction for policy in the
short- to medium term would be either to retain the current tight
stance of monetary policy or further tighten monetary policy.

The Committee’s Decisions
In view of these developments, the Committee was split between
retaining the current stance of monetary policy and further
tightening. Consequently, 6 members voted to retain the current
stance of monetary policy. Five members voted to increase private
sector CRR while while one member voted to increase public sector
CRR. In addition, one member voted for an asymmetric corridor
around the MPR. Consequently, the MPC decided by a majority vote
to:

(i) Retain the MPR at 12 per cent with a corridor of +/- 200 basis
points around the midpoint;

(ii) Retain the public sector Cash Reserve Requirement at 75.0 per
cent; and